Corrections natural in equity growth story

Let's look at Nifty returns of last 20 years. The Nifty level was 1,079.4 on December 31, 1997 and 10,530.7 on December 29, 2017. It comes to around 12.06 per cent CAGR over the 20-year period. Now add close to 1.4 per cent dividend yield. Total return from the Nifty is now 13.46 per cent. If you had invested 20 years ago in the Nifty, you would have had your portfolio grow at the rate of 13.46 per cent per annum compounded yearly.

It's very simple, 20 years' growth in nominal GDP has been close to this number. In 20 years the average GDP growth in real term (net of inflation) was around 6.91 per cent per annum and inflation has been around 6.49 per cent. GDP in absolute terms expanded 13.40 per cent

(6.91+6.49=13.40 per cent) per annum.

Corporate profit also expanded around the same number.

So the historic market returns came around like this. GDP growth plus inflation is equal to corporate profit growth. Corporate profit growth is equal to total market returns. Total market returns mean growth in indices plus dividend yield of indices.

The current market PE multiple is around 26-plus. Long-term average for PE multiple is around 19. The million dollar question is: Why is market at such high PE multiple as compared with its own long-term average?

Because in the last 10 years, GDP in absolute terms expanded by 14.96 per cent per annum and against this corporate profit growth expanded by just 5.5 per cent per annum. Market also expanded by almost similar numbers, the Nifty was 6138.6 on December 31, 2007 and 10,530.7 on December 29, 2017. This resulted in corporate profit as percentage of GDP going down from above 7 per cent to 4.96 per cent. In simple terms corporate profit lagged GDP growth and the market is expecting this to reverse and corporate profit to catch up with GDP growth. Today's market is discounting future earnings. Current quarterly results confirm this belief of markets where more corporate results were above expectations.

Now look at what may happen over the next 10/15/20 years. GDP may expand 6-7 per cent. Inflation can be around 4-6 per cent. Add both and we have GDP expansion in absolute numbers by 10-13 per cent. Corporate profit may grow faster in initial years because in the last 10 years it has lagged GDP growth. If the market trades at long-term PE of around 19-20, then it may grow around 10-13 per cent per annum from these levels.

Now the choices in front of investors are very simple.

Do you believe India's GDP will expand? If the answer is 'No' than you must worry about your real estate investments more than anything else.

If the answer is 'Yes', than: Do you believe corporate profit will expand in line with GDP? If 'No' then worry more about your business and job, for your kids; and less about your investments.

If 'Yes' then: Do you believe markets will be much higher than current levels? If 'No' than take money out immediately and never return back. If 'Yes' then: Do you believe that every percentage drop in market is a future gain if you invest regularly? If 'Yes' than you should welcome every fall in the market . The problem is drop in existing/invested portfolio. Well you want your portfolio to grow 2/3/5/10/20/50 times in future? Then some temporary drop is inevitable. It is not a permanent loss of capital but transitory blip which happened many times in last 20 years and will continue in future as well. On an average, ?1 lakh invested in mutual funds in India has become ?40 lakh in last two decade with temporary drop of close to 50 per cent at least three times.

Do you believe a good portfolio manager can add few percentages point to this 10-13 per cent numbers. If 'No' than invest in index / ETF Fund; and if your answer is 'Yes' than: Stay with your well-chosen funds. Rising markets are like scorching summers. Rise in mercury helps ripening and growth of crop but extended summer is not good for new sowing. Only rain god provides us new life. As a longterm investor I welcome every fall (we had not seen enough of this in last two years) like a farmer who welcomes rain drops after a scorching summer!

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